Soaring Food Prices: Causes, Consequences, and Remedies

Global food prices are currently at record highs. Despite their limited transmission to domestic prices of staple goods in developing economies, millions of people have been pushed into poverty. If there is another major supply shock in the near future, a serious food crisis could arise.

Hafez Ghanem of the Food and Agriculture Organization of the United Nations, Joseph Glauber of the U.S. Department of Agriculture, Will Martin of the World Bank, and Kimberly Ann Elliott of the Center for Global Development discussed the causes, consequences, and policy implications of the recent surge in international food prices. Carnegie’s Uri Dadush moderated.

This event was the second in a two-part series on commodity prices and their broader implications. The first event covered rising oil prices on March 31.

What’s Behind the Surge in Food Prices?

Panelists agreed that rising food prices are a reflection of supply-and-demand fundamentals: demand growth for food commodities has outstripped supply growth for several years, resulting in lower stock levels. Yields for major crops have been growing slowly for decades—limited by underinvestment in agriculture—while the demand for food has been increasing. As a result, the global food market, which exhibits low supply and demand elasticity in the short-run, has become more vulnerable to a series of shocks, including government policy responses, rising energy prices, exchange rate volatility, and adverse weather shocks.

• Bad Government Policy: Government policy responses, notably export restrictions, were a major factor behind the recent food price surge and increased volatility in the world market, said Martin. Panic buying by importing countries caused further price increases and volatility. Martin noted that by his estimations about half of the increase in rice prices in 2008 was due to measures taken by importing and exporting countries to insulate themselves from the rising price. Ghanem suggested that government policy responses were responsible for most of the rapid rice price increase in 2008, as neither poor harvests nor increases in demand preceded it. Similarly, Elliot pointed to poor U.S. policy—including a mandate, subsidy, and tariff, all intended to protect ethanol—as a main contributor to elevated corn prices.
   
• Energy and Food Prices: Ghanem explained that over the medium term the correlation between energy and food prices has grown: the use of corn for biofuels production has created a demand-side correlation, adding to the strong production-side correlation for oil in agricultural production. Glauber argued that the correlation between corn and energy prices has been declining recently. As the U.S. ethanol industry has approached its blend wall—the legal limit of how much ethanol can enter the fuel supply—the use of corn for ethanol production has grown less rapidly. In addition, a lot of corn production capacity has already been built.

Ghanem noted that, while all of the major food price spikes started with changes in market fundamentals, excessive speculation may have magnified the impact of those shocks.

Consequences

A sharp rise in food prices can significantly affect household consumption and nutrition, particularly in developing economies, where food accounts for a larger share of family budgets than in developed countries. But the current price surge has had a smaller impact on poverty than the last food-price crisis in 2007-2008. The current crisis has forced 44 million additional people into extreme poverty (defined as earning less than $1.25 a day) since last June, compared to 75 million in the 2007-2008 crisis.

• Limited Transmission to Domestic Prices: According to Ghanem, good harvests in many African economies actually led the prices of major staple crops, such as maize and sorghum, to decline. In Asia, the moderate increases in the price of rice—a major food staple there—have helped about 500 million people avoid going hungry, Elliott added. But smaller countries are still more vulnerable than larger developing countries to price changes, Ghanem warned.
   
• Composition of the Increase: While food prices overall are at their highest levels on record, according to Ghanem, sugar and oils have seen the biggest increases, whereas the 2007-2008 price surge was led by cereals. Martin explained that prices have not increased as much as in the 2008 food-price crisis, though they started from a higher level and ended up roughly where they were at the peak of 2008.
   
• Advanced Economies: While food prices are an important driver of inflation in developing economies, their impact is smaller in advanced countries, noted Glauber. In the United States, the farm value of food makes up less than 20 percent of its retail cost, reflecting the high contribution of processing, marketing, and transportation in its overall cost.

Not Out of the Woods

Panelists agreed that, with the market already tight, food prices are expected to remain high in the coming years.

• Tight Market in the Short-run: Glauber predicted that, even with the additional corn supplies in the U.S. expected this year, low stocks combined with inelastic demand will keep food prices high and very volatile in the near future. Ghanem added that a serious food crisis could arise if another supply shock hits a major exporting country—as a result of bad weather, for example.
   
• Medium-Term Outlook: Food prices are likely to decline from their current high over the medium term, but will remain higher than in the past as demand continues to grow, said Ghanem. Glauber argued that the demand for biofuels in the United States will not grow by as much as before. Barring any shortfall due to weather, he predicted some rebuilding of corn stocks over the next five years, which would decrease volatility.

Policy Implications

• Invest in Agriculture: Ghanem suggested that developing-country governments need to reallocate resources to agriculture to spur productivity. Investments in transportation facilities, storage, and market access can help reduce post-harvest losses—which reach about 40 percent in developing countries—and help farmers generate more income. Martin argued that investment in research and development is particularly important, as it improves productivity in the long term.
   
• Improve Trade Policies: According to Ghanem, improving trade policies and promoting freer trade in agricultural commodities is important in the long run for reducing volatility and providing the right incentives for farmers to make investments. An agreement in Doha trade negotiations could be a first step toward free and open trade, which can help ensure food security.
   
• Targeted Safety Nets: Sharp rises in food prices significantly burden poor consumers. According to Elliot, governments should mitigate the impact of price increases and volatility by providing cost-effective, targeted assistance—such as conditional cash transfers—to those in need, rather than resort to market policies, such as generalized subsidies and tax cuts, which are expensive and inefficient.